Tax Insight

Proposed regulations address Section 898 transition rules and Section 960(d)(4) FTC disallowance

Insight
5 minute read
August 03, 2026

What happened?

Treasury and the IRS released, on July 31, 2026, proposed regulations under Sections 898(c) and 960(d)(4). The proposed regulations implement the One Big Beautiful Bill Act (OBBBA) transition from the one-month controlled foreign corporation (CFC) deferral year, prescribe how certain foreign taxes are allocated between the short first required tax year and the succeeding tax year, and apply the statutory 10% foreign tax credit disallowance to taxes associated with distributions of post-June 28, 2025, Section 951A previously taxed earnings and profits (PTEP). These proposed regulations largely adopt the frameworks introduced in Notices 2025-72 and 2025-77, but with some accommodations in response to comments.

Why is it relevant?

The proposed Section 898 rules could materially affect the timing and usability of foreign tax credits for US groups with CFCs that previously used the one-month deferral election. The transition rule in OBBBA created potential mismatches between foreign-law income, foreign tax accruals, and the corresponding US income groups, potentially resulting in a complete loss of foreign tax credits in some circumstances. Those mismatches could affect the amount and timing of deemed-paid foreign tax credits; subpart F and Section 951A computations; high-tax exception and high-tax exclusion determinations; tested income and tested loss calculations; PTEP accounts and related tax pools; foreign tax redeterminations and currency translation; and Form 5471 reporting and supporting workpapers. The proposed regulations address these concerns and provide taxpayers with significant elective flexibility. Specifically, the proposed regulations introduce four new elections: (1) allocation of taxes based on specific income groups as opposed to aggregate foreign taxable income, (2) allocation of certain taxes imposed on a partnership that is required to change its tax year as a result of a change of the tax year of one of its partners, (3) no allocation of taxes to the first full post-Section 898(c)(2) repeal tax year (i.e., the succeeding tax year), and (4) an election to allocate certain taxes paid or accrued in the succeeding tax year to the one-month first required tax year.

The elective provisions could produce significantly different results depending on the timing and character of income. For example, an income-group-specific allocation may preserve credits where a CFC earns different categories of income in its short year and succeeding year, but it could require more detailed foreign-law income data and closing-of-the-books calculations. An example cited to illustrate the need for this election is where taxes are imposed on income (e.g., passive income from a sale of stock) of a type that will not be recognized in the following tax year.

Notice 2025-77 clarified the effective date of Section 960(d)(4) applies to foreign income taxes paid or accrued (or deemed paid under Section 960(b)(1)) for a Section 959(a) distribution to the extent the PTEP results from a Section 951A inclusion of a US shareholder in a tax year ending after June 28, 2025. Consistent with the Notice, the Section 960(d)(4) proposed rules also increase the importance of accurate PTEP tracking. Taxpayers will need to distinguish PTEP based on whether the associated Section 951A inclusion arose in a US shareholder tax year ending before or after June 28, 2025. This distinction can affect the amount of foreign tax credit available when cash is distributed through one or more tiers of CFCs.

Actions to consider

With respect to the Section 898 proposed rules, taxpayers should identify affected CFCs and partnerships, model the default and elective allocation approaches, and prepare Form 5471 reporting and election statements in accordance with the proposed requirements. With respect to the Section 960(d)(4) proposed rules, taxpayers should update PTEP tracking systems and report Form 5471 accurately. The proposed regulations were published in the Federal Register on August 3rd and taxpayer comments are due by September 17, 2026. The Section 898(c) rules are proposed to apply to tax years of specified foreign corporations beginning after November 30, 2025. The Section 960(d)(4) rules generally apply to taxes associated with Section 951A PTEP arising from US shareholder tax years ending after June 28, 2025. Taxpayers may rely on the proposals before finalization if they apply the relevant rules in their entirety and consistently. Treasury and the IRS expect to finalize the regulations by January 4, 2027.